Economists are increasing optimistic on the outlook in large part because household incomes are up, and consumer spending has largely followed. But it’s not just current income, we know asset markets are strong as well. Wealth is increasing, which supports additional consumer spending should households want or need it. While stock market wealth is very concentrated among high-income households, real estate wealth is a bit more broadly distributed, and is the key source of wealth for households in the middle and bottom parts of the distribution.
Given home price appreciation and a rising homeownership rate in recent years, the total value of owner-occupied housing is increasing faster than the overall economy as seen in the chart below. For now this excludes rental properties as some of those equity gains go to owners outside of the region, and the rental income from those properties shows up in the current income data.
But looking at the total value of housing overstates the real situation because it does not account for mortgage debt. The next chart tries to adjust for that. These estimates are built off of median mortgage debt and home equity lines of credit information, coupled with median home values. Then adjust those for the share of households who own their home free and clear and the like. While it’s a decent, rough estimate of owner-occupied equity in Oregon, it is also an underestimate of the true number because it is but off medians and not averages (average debt data is not readily available).
Even so, the patterns are very clear. Home equity is much larger today, relative to the size of the economy, then back during the housing bubble. There is a considerable amount of housing wealth that remains largely untapped today. And of course the Bend MSA really stands out on this chart. I was honestly surprised at the sheer size of home equity when I first put this together. I’ll come back to this in the near future, but the relative size of housing wealth in Bend puts it pretty rarefied air when looking across the nearly 400 metro areas around the country.
While the rise in home equity is clearly relevant from a personal finance perspective, what does it mean for the economy more broadly? That’s a little bit harder to say. I’ve spent some time lately re-reading a few research papers. As expected, the main conduit for broader economic implications is through consumer spending.
One of the landmark academic papers from Mian, Rao, and Sufi (2013) finds that the marginal propensity to consume out of housing wealth is 5-7%. That means if your home equity increases $10,000, then you will spend an additional $500-700. More recent research from Moody’s Analytics (no link) estimates that figure is closer to 4% in the years since the housing bubble burst. Even so, with home equity rising by tens of billions of dollars in Oregon last year, that would support additional consumers spending by hundreds of millions, if not a full billion of dollars.
Of course home equity isn’t liquid. One has to do a cash-out refinance, or take out a home equity line of credit or the like to access the wealth and spend it. As Calculated Risk has been tracking over the years, mortgage equity withdrawal has been really tame since the bubble, although it has picked up this year for the first time in a decade. Given the strong home equity position, and record low interest rates, it is possible that we will see more mortgage equity withdrawal moving forward as well, if it is needed.
So what do people do when they withdrawal equity? Recent research out of the Federal Reserve shows that many households spend it on home improvements, furnishings and the like. In other words the most common thing is taking out equity to improve or update the house itself. Other things households do is save a lot of it initially, likely to spend or invest it in the years ahead, or consolidate other forms of debt, with only relatively small amounts spent on other types of things like autos. Generally speaking households don’t treat home equity as an ATM. They seem to generally have a plan, which is great!
Given households incomes are up and the economy is not fully open, what else could households be spending their equity on in the last year? One thing to keep in mind is that we know personal savings and home equity are the major source of funding for small businesses. See the Federal Reserve’s Small Business Credit Survey for more. Even as the economy is doing much better than feared, businesses have struggled. Given the timing here, I think it makes a lot of theoretical sense that some of the recent equity withdrawals are being used to support businesses. Time will tell to what extent that is actually the case.
Finally, another option could be retirees maintaining their general spending or paying for long-term care which can amount to tens of thousands of dollars a year. This was a possibility brought up on Twitter by former Oregon Representative Julie Parrish, with a few others chiming in saying it’s a big, and growing need as the population ages. As our office has discussed before, many retirement-aged households do not have adequate private savings and social security accounts for the bulk of their income. So using home equity as a source of income would make sense when it is needed.
To this point, we know there is a growing number of homeowners who own their homes free and clear. They have lived in them a long time and have paid off the mortgage. This is expected to continue to increase in the years ahead, due to the Baby Boomers retiring. Now, a couple complicating factors here is that the Fed research noted above shows that mortgage equity withdrawal is something that 40-somethings do the most, and 60- and 70-somethings do the least. Additionally, we know downsizing also isn’t really a thing. As such, it is probably reasonable to expect long-time homeowners to largely sit on their equity until the day comes when they either have to move into some sort of assisted living, or their finances dictate a need.
All told, home equity has been increasing considerably in the past decade. Current homeowners are in much better financial positions than they were a decade or two ago. Just how much this equity will support consumer spending and future economic growth is still to be determined. Even without a big increase in mortgage equity withdrawal, it could add a couple tenths of a percent to annual GDP growth. Of course not all of this is good news. The system we have in place where homeownership is the best (only?) path to wealth building for most households isn’t great. Housing cannot be both affordable and a good investment, outside of the forced savings part and paying down debt. One reason equity has risen is due to the undersupply or relative lack of new construction driving prices higher.
Stay tuned, I have a lot more along these lines coming in the near future including an update on construction relative to population growth, comparing housing wealth across metro areas, and digging further into the latest Survey of Consumer Finance to look at the stock of unrealized capital gains.